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Long after the coronavirus crisis is over, we will live with the debt

Sunday Times Economics Editor David Smith writes an exclusive column for ICAEW’s Financial Services faculty every month. This month he considers the debt the coronavirus response is creating.

For those who thought that we would never see anything quite like the global financial crisis for its impact on government debt, coronavirus is providing a rude awakening.

The world recession is deeper this time than then and, according to the International Monetary Fund, global government debt will rise from 83% to 96% of world gross domestic product this year.

This is equivalent to a rise of $11 trillion (£8.9 trillion), or more than £1,100 for every man, woman and child on the planet. 

Among advanced economies, debt will rise from 105% to 122% of GDP. More and more rich countries will thus join the 100% club, where their debt exceeds annual national income.   

In Britain, meanwhile, a 10-year effort by George Osborne and Philip Hammond to get government debt falling relative to gross domestic product has been blown away in less than 10 weeks.

The independent Office for Budget Responsibility’s coronavirus scenario has the budget deficit rising to £273 billion or 14% of GDP this year – significantly higher than during the global financial crisis – and debt rising to more than 100% of GDP, if only temporarily.

When things settle down, the permanent addition to debt will be more than £200 billion, or 10% of GDP, the fiscal watchdog fears. 

These are huge numbers, and they raise many questions.

Are central banks already “monetizing” debt, in other words, printing money to enable governments to turn on the spending taps in response to the crisis. This is one of those times when, if it looks like a duck and quacks like a duck it probably is one.

The fact that the Bank of England has, through the Ways and Means count, effectively given the Treasury an unlimited overdraft, adds to the suspicion that we are seeing monetary financing of government debt. 

Andrew Bailey, the new Bank governor, denies this.

The Ways and Means overdraft is a cash-flow issue, not a debt one, he argues, and it was employed during the financial crisis.

The £200 billion of extra QE the Bank has announced, which is being used to buy gilts in the market, is on exactly the same terms as previous rounds.

But the extra QE, which will take the total to £635 billion, comes on top of rounds which have yet to be unwound. The same is true of other central banks.

The point is that we will only know that QE was not monetary financing when the government bonds purchased have been sold back into the markets. We are a very long way away from that.

The ratings agencies have been hovering with their red pens poised amid this debt explosion, but so far are giving most countries the benefit of the doubt, on the assumption that countries will return to growth, and more modest budget deficits, quite quickly.

S & P, in leaving the UK’s sovereign debt rating unchanged at AA, cited the “monetary and fiscal flexibility” shown by the UK authorities, though its rival Fitch downgraded the UK by a notch, and imposed a negative outlook, in late March. 

The big increase in debt has resurrected some familiar arguments. In the aftermath of the financial crisis, the Bank of England justified QE against the accusation that it had benefited asset-rich older people by saying that it been responsible for keeping many younger people in jobs.

The coalition government’s austerity programme was justified on the basis that it was not right to pass on a huge debt burden to future generations.

What about now? The Treasury and the Bank, and their counterparts in other countries, can claim that their emergency actions will have reduced the extent of economic “scarring”, which impacts significantly on the young.

Without emergency measures, in other words, the rise in unemployment that we are seeing would be much, much worse. The debt that results will still, of course, be passed on to future taxpayers, and current ultra-low interest rates will not last forever. 

One thing there can be little debate about is that this has come at a terrible time for government debt.

A while ago, the OBR published projections for UK government debt relative to GDP in coming decades. They showed that, under the impact of ageing populations, and without offsetting action by the government of the day, debt levels would rise alarmingly from the 2020s onwards, eventually reaching some 260% of GDP in the second half of the 21st century.

The Organisation for Economic Co-operation and Development published projections showing a similar pattern for most Western economies.

If you think the world is drowning in government debt now, there is much more to come. The coronavirus crisis has ensured that this debt surge, if it is allowed to happen, will start from a significantly higher base.  

You can read more of David Smith's previous editorials on the Financial Services hub page.